Scenario Analysis For Friday’s Trading Session

The S&P is currently in a range between 4950 and 5250. After blowout earnings from Google (GOOG/GOOGL) and excellent earnings from Microsoft (MSFT) Thursday afternoon, the market is going to gap up at Friday’s open. The question is: What happens after that? I see three scenarios.

The first scenario is a “gap and go”. The market gaps up at the open – and keeps melting up higher throughout the day. The level bulls want to see taken out – and bears want to see hold – is the 50 DMA at 5122 – about 75 points higher than Thursday’s close. In this first scenario, the S&P bursts through the 50 DMA, putting an end to the correction over the last few weeks. I think the market is placing about a 40% probability on this scenario.

In the second scenario, the S&P gaps up – but can’t get through the 50 DMA. After the gap up at the open, it moves mostly sideways for the rest of the day, leaving things to be resolved next week. I think the market is placing about a 60% probability on this scenario.

Almost everybody expects one of these two scenarios to play out tomorrow. But there is a third.

In the third scenario, the S&P gaps up at the open – but meets resistance near the 50 DMA and reverses hard to the downside. Perhaps 4950 even gets taken out, resolving the range in favor of the bears and supporting my thesis that the rally of the last 18 months is over.

How could that possibly happen? It can happen if all of the good news is already priced in and after the gap up, everybody is positioned long. In that case there would be no demand/buyers for stock above the 50 DMA and the market could reverse hard to the downside. While the least likely of the three, I wouldn’t rule it out. However, I think the market is placing almost no chance on this scenario.